If your business has consistent cash flow challenges the likely cause is a profitability issue in disguise (meaning that you aren’t profitable enough to cover the expenses required to run your business)… but today I want to talk about businesses that "have it all figured out” and are consistently profitable (after all, good businesses are consistently profitable).
Let’s use an agency that does 7 million in annual revenue, as our example. The leadership team is seasoned and has the right industry connections. Last year, they had an operating margin of 19% ($1,330,000) but they feel stagnate and they have never had margins greater than 20%.
How do they move from 19% margins to 25% margins?
Understand and optimize client profitability (adds 3-6% margin)
Cash Management (adds 0.5 - 1.5% margin)
If you have a clear understanding of client profitability… you can drive the business toward the most profitable clients and tasks (and away from the opportunities where you don’t have healthy margins). I call this a sweet spot analysis. For profitable businesses, this can increase operating margin by 3-6% (and it can have an even more dramatic effect on struggling businesses).
The example below shows the profitability of the top ten clients for our example agency. Using the column on the far right (Operating Margin) it becomes immediately obvious which clients present a profitability challenge. Now you can go fix it (I’m not implying that this is easy) and take a huge step to increasing your margins. As an aside, I will remind you that the most profitable agencies are the ones who occasionally fire clients (and while I’m not saying that is the right option here, it does have to be one tool available to you).
Example of a client profitability analysis for an agency
The last point on improving margins relates to being smart with your cash on hand. Digital services businesses like the agency above should keep 10-30% of annual revenue in cash (as part of the tax provision, business savings, bonus pool, etc.). If you manage that cash wisely it can lead to another 1% increase in operating margin. This can be implemented in many ways from a super simple process to a complex process involving a treasury management team (or software), but the point is: don’t leave this “free money” behind.